U.S. Sees Shift in China's Tone on Yuan

By

Ian Talley,

Bob Davis And

Jason Dean

Updated Jan. 22, 2011 12:01 a.m. ET

WASHINGTON—U.S. officials, parsing every word that Chinese President Hu Jintao and his delegation uttered in a visit here this past week, said there were subtle signs they were preparing to let the yuan appreciate faster.

But the signs are purely linguistic and U.S. officials are watching to see whether the words are matched by action over the coming months. So far the Chinese currency has been appreciating, on average, about 0.5% a month against the dollar since mid-June when Beijing said it was adopting exchange-rate flexibility. The U.S. Treasury has signaled it is looking for appreciation at twice that rate.

"We will stay closely and intensively engaged with China as it navigates a course towards an increasingly market determined and international currency," said Treasury Undersecretary Lael Brainard in a talk at the Council of Foreign Relations in New York on Friday.

Currency traders also said they were watching and waiting. "It may hint that we see some more aggressive fixing of a firmer yuan against the dollar," said Chris Turner, head of foreign-exchange strategy at ING Financial Markets in London. "But we'll judge them more by their deeds than their words," he said.

More on China

U.S. officials pointed to three changes in language and tone in currency discussions.

First, China dropped previous references to "maintaining basic stability at an equilibrium rate," Ms. Brainard said. Washington has long interpreted that phrase to mean that China will let the currency move only at a gradual rate for fear that a faster acceleration could undermine China's export industry.

U.S. officials noted that Hu Xiaolian, deputy governor of China's central bank, as recently as late December used the standard formulation that the exchange rate was aimed to "maintain the basic stability" of the yuan "at a reasonably balanced level."

Second, U.S. officials say, China noted in talks the relationship between the exchange rate and its broader goal of transforming its economic development model. Washington interprets that to mean that China has come to recognize that letting the currency rise would help it shift away from an export-led model, which produces fast GDP growth, but job growth of only about 1% a year.

A stronger yuan would boost the purchasing power of ordinary Chinese, the U.S. has long argued, and strengthen the domestic market. That could enhance Chinese service companies and increase the pace of job creation. While Beijing has long said such rebalancing was its goal, household consumption, as a percentage of the GDP, remains far below the levels of other major countries.

Third, the language on currency in a U.S.-China communiqué says that China is committed to exchange-rate flexibility "to promote the transformation of its economic development model." However, it's unclear whether that represents a departure. Chinese central bankers have emphasized since June that a flexible exchange rate can help restructure the economy. In a July essay, for example, Ms. Hu, the deputy governor, said the new exchange-rate regime can "transform the pattern of economic development," "enable domestic demand to play a more important role in economic development," and "promote sustainable and balanced economic growth."

ENLARGE

Notably absent from the Treasury analysis was any claim that China had decided to use the exchange rate specifically to fight inflation—a course of action that would argue for a much faster rate of appreciation.

Before Mr. Hu went to Washington, U.S. Treasury Secretary Timothy Geithner urged China to use foreign-exchange policy to battle inflation.

But Mr. Hu, in answers to questions submitted by the Wall Street Journal and the Washington Post, played down inflation, saying it is just one of many factors determining the exchange rates. There is little to suggest that he changed course after talking with Mr. Obama and other U.S. officials

Reading Chinese intentions from its words is a difficult task. The absence or presence of the words "basic stability" by itself isn't conclusive proof. Chinese officials used that phrase many times between 2005 and 2008, when it let the currency rise. Many economists in China expect the rate of appreciation to continue at roughly the 0.5% a month course it's been on since June.

There's also little else to indicate that Chinese leaders will drop "stability" as the fundamental principle they use to manage the currency. Under Communist Party rule, China aims to avoid sharp changes that could be economically destabilizing.

This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit www.djreprints.com.